It Asda be done

The thing about Asda is that no one has ever really known what its purpose is. It was the Yorkshire milkman that, for a while and almost by accident, became a fast-growing supermarkets operator. Then it could not decide whether to stick to its cheap’n’cheerful formula or attempt the transition to a grown-up value-added retailer with own-label brands that affluent shoppers would take seriously.

Unlike its Yorkshire neighbour, Wm Morrison (MRW), it lacked the guiding hand of an obsessive controller, Ken Morrison, whose modesty and dedication – much like Sam Walton’s at Walmart – kept the company on a sensible course most of the time. So it tried some really weird stuff, including the outrageous merger with flat-pack furniture retailer MFI in 1986; although that was chiefly to bring on board MFI’s boss, Derek Hunt, who was a retailing ideas’ factory.

Not even Mr Hunt’s nous could put logic into a combo of Asda and MFI and that deal was unravelled within two years. But Asda continued to lurch from foul-up to cock-up, capping them all in 1989 with the £705m acquisition of Gateway, which was as much an accounting mirage as a supermarkets chain. That snafu almost did for the company, but then it got lucky when Archie Norman, now the new chairman of Marks & Spencer (MKS) but then a young finance director with a fortune to make and a reputation to cement, engineered Asda’s recovery by re-shaping it as a scaled-down UK version of Walmart in the 1990s. The imitation enticed in the real thing when Walmart, the world’s biggest retailer, bought Asda for £6.7bn in 1999.

So why is £7.3bn such a great price now – 19 years and a lot of capital spending later? Chiefly because the UK has become a distraction for Walmart and it gets £3bn of cash upfront and a continuing 42 per cent interest in the enlarged Sainsbury. If the £500m-worth of synergies promised by Sainsbury’s bosses come through, then, even without any growth, Walmart would capture a 15 per cent return on its locked-in investment two years after completion of the deal. For a low-growth industry such as supermarket retailing that looks pretty good.

Hence the joy in downtown Bentonville. But, of course, we both fictionalise that and exaggerate it. It’s not as though Sainsbury is necessarily being legged over. That’s chiefly because it is acquiring what appears to be a regular cash generator (see table). True, Asda’s impressive production of free cash – it averaged over £500m a year in the 10 years to 2016 – may owe something to comparatively low levels of capital spending. But even if its rate of capex had been the same as Sainsbury’s 3.5 per cent of revenues over the past five years, Asda would still have managed £375m of free cash a year. By contrast, Sainsbury’s free cash flow in the five years to March 2017 averaged next to nothing – not that it prevented management from paying £1.45bn-worth of dividends in that period.

Meanwhile, Sainsbury’s bosses justify the deal entirely in the terms of conventional business-speak. They enthuse about synergies, value creation, enhanced scale and – worst of all – “double-digit earnings accretion”, which sounds a bit like an assault on the person as well as on the language. But the truth of the matter is that this deal is about two vulnerable players operating in a low-growth industry that’s deep in turmoil grabbing the opportunity to go for size, always the defence of choice for the feeble. That opportunity was created by the remarkable decision of the UK’s competition regulator to nod through this year’s £3.7bn takeover of Booker by Tesco (TSCO) with barely a murmur. Whether Sainsbury and Asda are quite so lucky remains to be seen, but Sainsbury’s management does not expect the deal to complete until the second half of next year anyway.

‘Low growth’, however, does not mean ‘no growth’. While the UK’s retailing industry is being battered by the combined attack of Amazon on its business model and Brexit on consumers’ spending power, it is easy to forget the marvellous stability of food retailing. Look around and you’ll see an awful lot of people who all have to eat and they have to buy their food from somewhere.

So, while the market’s initial response to the deal may be over the top – at 314p, Sainsbury’s shares are as high as they have been for almost four years – when the price returns to around 250p (at which level the dividend yield would top 4 per cent) the shares may be a decent income-and-recovery play.